StarHub - RHB Invest 2018-09-06: Stamping Its Mark In Cybersecurity

StarHub - Stamping Its Mark In Cybersecurity

StarHub has announced the merger of its cybersecurity arm with Temasek-owned Quann to create one of the largest pure play end-to-end cybersecurity outfits in Asia: Ensign. The deal structure provides for the crystallisation of some value of its investments from Year 3, for which it is forking out SGD52m (net outlay: SGD36m), in exchange for new shares. Assuming Ensign generates revenue in excess of SGD100m pa and a 15% net margin (ex-management charges), we estimate net earnings accretion of 0.7% for FY18 and 4.7% for FY19, all else being equal.

While the merger is positive to drive scale and scope, we leave our core earnings forecasts unchanged for now, as we expect synergies to accrue over time with a progressive ramp-up over the next 1-2 years.

Merger with Temasek’s cybersecurity (CS) outfit.

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StarHub has announced the merger of its CS arm – which includes Accel Systems & Technologies (ASTL) – with Temasek’s Quann, a leading regional CS services provider, to form one of Asia’s largest CS outfits. The multi-prong exercise will see the creation of a pure play CS provider with end-to-end capabilities. This would be via parallel asset injections in exchange for cash/shares in a new JV company: Ensign InfoSecurity (Ensign).

Post completion of the exercise (slated for end-October), StarHub is to have a 60% economic interest in Ensign, with the remainder being held by Leone, a Temasek subsidiary.

The merger is intended to drive scale and accelerate the growth of its CS business, which is currently parked under the fast-growing enterprise fixed revenue segment (21% of 1H18 group revenue).

Mechanics provides opportunity to realise some value from Year 3.

StarHub will be injecting its CS business (including ASTL) into the JV for SGD16m and a 40% stake in Ensign. Subsequently, it would procure an additional 20% shares in the form of economic benefits and rights transferred for SGD52m. The assigned rights should ensure rapid growth of the merged outfit in the initial years, allowing the group to crystallise part of the value of its investment from Year 3.

Overall, we view the exercise positively, as it should catalyse and accelerate the growth of StarHub’s CS business – a key longer-term thrust of the group. It should also provide an opportunity for the crystallisation of its CS investments, with the option to transfer its 20% economic interest back at fair market value to Temasek.

It would also better position StarHub to grab a bigger slice of the lucrative CS market in Singapore, which is valued at > SGD700m currently and projected to hit SGD1bn by 2020.

The deal is expected to be earnings accretive from the onset, but we expect merger synergies to accrue over time.

Based on pro-forma numbers, the net earnings impact from the exercise is guided at c.SGD2.75m (1.75% of StarHub’s 1H18 earnings). This comprises SGD3.03m profit from the existing CS business (including ASTL) and a SGD0.32 loss from Quann. The latter would have been profitable if not for high management charges incurred.

While management expects cost implications of the exercise to be small, it is confident that Ensign’s profitability (net margins) should rise to the mid-teen levels with the removal of management fees post- merger. Assuming Ensign generates in excess of SGD100m revenue pa and net margin of 15%, we estimate net earnings accretion of 0.7% for FY18 and 4.7% for FY19, all else being equal.

StarHub said the exercise should not impact its dividend payout for FY18: SGD0.04/quarter.

Maintain NEUTRAL and DCF-based Target Price of SGD1.78, 10% upside.

While the deal is positive and earnings accretive, we expect merger synergies to accrue over time, with progressive ramp-ups over the next two financial years. As such, we leave our core earnings forecasts unchanged for now.

StarHub trades at 6.6x FY19F EV/EBITDA, at -1.5SD below its historical mean. We believe valuations are fair, given the competitive risks in the market – eg new mobile virtual network operators (MVNO) and the impending rollout by TPG Telecom – and potential downside to dividends.

Key risks of the exercise: higher opex from the merger and slower merger synergies. The latter is likely to impact on the crystallisation of its investment in Ensign.

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